Paul Harris' Top Picks: June 26, 2020

Paul Harris, partner and portfolio manager at Harris Douglas Asset Management
Focus: North American and global stocks

MARKET OUTLOOK

As long-term investors, we are doing our best to ignore the day-to-day distractions. One thing we do know is that great companies will persist. If you owned a mediocre business heading into this pandemic, it is unlikely that the company will be a better business after COVID-19. We buy high-quality companies that offer a high margin of safety. These companies have high and growing returns on capital, pricing power that is improving over time, growing free cash flow, strong balance sheets with flexibility to take on debt if needed and an asset-light business — businesses that do not require significant ongoing capital expenditures to make a product or service.

COVID-19 has changed companies and they can never go back to the way things were. It has turbocharged the growth of the internet and catapulted us into the future. We have become a mobile society with mobile workers. This theme has and will continue to play out in investing areas like technology and communications, along with healthcare and healthcare technology, consumer staples and discretionary, Amazon Costco and  Walmart will continue to do well; retail, oil and gas and resources will perform poorly. The S&P price-to-earnings is in the top 10 per cent of its history, but the economy is in the bottom 10 per cent. Every crisis is different and unanticipated outcomes are guaranteed, therefore I would advise caution and patience.

TOP PICKS

ZOETIS (ZTS NYSE)

Zoetis is the largest public animal health company. It was spun off from Pfizer in 2013.

In 2018, U.S. pet owners spent $15.5 billion on over-the-counter medicine and supplies, doubling the amount since 2001. Healthcare for animals has a certain advantage over health for humans: The sector doesn’t have content with pricing pressure from the insurance industry, as most medical expenses are paid out of pocket. Developing drugs for pets, compared with for humans, is also generally faster and less expensive, since it requires fewer clinical studies that involve fewer subjects. Most companies try to find compounds that have worked in humans, so we don’t to start from scratch. Generic drugs are less of a threat.

The company has strong free cash flow growth, generating $1.5 billion in 2021, a strong balance sheet and covers interest on debt 14 times and high conversion rates in free cash flow to net income.

STRYKER CORPORATION (SYK NYSE)

Stryker is one of the world’s leading medical technology companies. The company offers innovative products and services in orthopaedics, medical and surgical, neurotechnology and spine. With the acquisition of Wright Medical, Stryker will have products for hands and ankles, improving patient and hospital outcomes. The company has 73 per cent of its business in the U.S., 21 per cent in international developed markets and 6 per cent in emerging markets. This is a great demographic play: as the population ages, Stryker’s product become more useful and helpful. Furthermore, there is somewhat of an annuity with med tech products as once surgeons start and learn, they tend not to change.

Stryker is a well-diversified company and with its strong balance sheet it should be able to manage through any macroeconomic pressures. Stryker is generating nearly $2.6B billion of free cash flow in 2021, of which about 25 per cent is being used for dividends. This still leaves the majority of Stryker’s annual free cash flow that could be used for M&A and pay down debt. They cover their interest payments 11.4 times and have a high free cash flow conversion rate.

AMADEUS IT GROUP SA (AMADY OTC) 

This is a Spain-based company engaged in the provision of information technology (IT) services, primarily for the tourism and travel industries. Two business segments: distribution and IT solutions. The distribution division offers Global Distribution System (GDS), a worldwide computerized reservation system (CRS) used as a single point of access for booking airline seats, hotel rooms and other travel-related services by travel agencies and travel management companies. The IT solutions division provides a range of technology solutions that automate core processes for travel providers.

Its customers include full service carriers and low-cost airlines, hotel managers, rail operators, cruise and ferry operators, travel insurers and car rental companies, among others. Amadeus has a yield of 1.3 per cent, covers its interest payments 16 times, converts 95 per cent of free cash flow to net income and is expected to have 800 million in free cash flow in 2021.

PAST PICKS: JULY 2, 2019

LOCKHEED MARTIN (LMT NYSE)

• Then: $367.57
• Now: $363.55
• Return: -1%
• Total return: 1%

VISA (V NYSE)

• Then: $175.28
• Now: $192.29
• Return: 10%
• Total return: 10%

DISNEY (DIS NYSE)

• Then: $142.53
• Now: $109.92
• Return: -23%
• Total return: -22%

Total average: -4%